Problem 5-1

Bond Valuation with Annual Payments

Jackson Corporation's bonds have 5 years remaining to maturity. Interest is paid annually, the bonds
have a $1,000 par value, and the coupon interest rate is 8%. The bonds have a yield to maturity of
6%. What is the current market price of these bonds? Round your answer to the nearest cent.
$
1,168.49

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Solution

With your financial calculator, enter the following:

N = 5; I/YR = YTM = 6%; PMT = 0.08 x 1,000 = 80; FV = 1,000; PV = V B = ?

PV = $1,084.26.
Alternatively,
VB = $80((1 - 1/1.065)/0.06) + $1,000(1/1.065)

= $1,084.25
Solution
Correct Response

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Problem 5-1
Bond Valuation with Annual Payments
Jackson Corporation's bonds have 5 years remaining to maturity. Interest is paid annually, the bonds
have a $1,000 par value, and the coupon interest rate is 8%. The bonds have a yield to maturity of 6%.
What is the current market price of these bonds? Round your answer to the nearest cent.
$
1084.25

Problem 5-2
Yield to Maturity for Annual Payments
Wilson Wonders's bonds have 12 years remaining to maturity. Interest is paid annually, the bonds
have a $1,000 par value, and the coupon interest rate is 10%. The bonds sell at a price of $850. What
is their yield to maturity? Round your answer to two decimal places.
%
10.23

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Solution

With your financial calculator, enter the following:

N = 12; PV = -850; PMT = 0.1 x 1,000 = 100; FV = 1,000; I/YR = YTM = ?

YTM = 12.48%.
Solution
Correct Response

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Problem 5-2
Yield to Maturity for Annual Payments
Wilson Wonders's bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have
a $1,000 par value, and the coupon interest rate is 10%. The bonds sell at a price of $850. What is
their yield to maturity? Round your answer to two decimal places.
%
12.48

Problem 5-3
Current Yield for Annual Payments
Heath Foods's bonds have 12 years remaining to maturity. The bonds have a face value of $1,000 and
a yield to maturity of 7%. They pay interest annually and have a 11% coupon rate. What is their
current yield? Round your answer to two decimal places.
%

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Solution

With your financial calculator, enter the following to find the current value
of the bonds, so you can then calculate their current yield:
N = 12; I/YR = YTM = 7%; PMT = 0.11 x 1,000 = 110; FV = 1,000; PV =
VB = ?
PV = $1,317.71. Current yield = $110/$1,317.71 = 8.35%.
Alternatively,
VB = $110((1 - 1/1.0712)/0.07) + $1,000(1/1.0712)

= $1,317.71.
Current yield = $110/$1,317.71 = 8.35%.
Solution
Correct Response

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Problem 5-3
Current Yield for Annual Payments
Heath Foods's bonds have 12 years remaining to maturity. The bonds have a face value of $1,000 and
a yield to maturity of 7%. They pay interest annually and have a 11% coupon rate. What is their
current yield? Round your answer to two decimal places.
%
8.35

Problem 5-3
Current Yield for Annual Payments
Heath Foods's bonds have 8 years remaining to maturity. The bonds have a face value of $1,000 and a
yield to maturity of 8%. They pay interest annually and have a 6% coupon rate. What is their current
yield? Round your answer to two decimal places.
%
8

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Solution

With your financial calculator, enter the following to find the current value
of the bonds, so you can then calculate their current yield:
N = 8; I/YR = YTM = 8%; PMT = 0.06 x 1,000 = 60; FV = 1,000; PV = V B = ?

PV = $885.07. Current yield = $60/$885.07 = 6.78%.

Alternatively,
VB = $60((1 - 1/1.088)/0.08) + $1,000(1/1.088)
 = $885.07.
Current yield = $60/$885.07 = 6.78%.
Solution
Correct Response

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Problem 5-3
Current Yield for Annual Payments
Heath Foods's bonds have 8 years remaining to maturity. The bonds have a face value of $1,000 and a
yield to maturity of 8%. They pay interest annually and have a 6% coupon rate. What is their current
yield? Round your answer to two decimal places.
%
6.78

Problem 5-4
Determinant of Interest Rates
The real risk-free rate of interest is 4%. Inflation is expected to be 2% this year and 5% during the next
2 years. Assume that the maturity risk premium is zero.
What is the yield on 2-year Treasury securities? Round your answer to two decimal places.
%
7.5
What is the yield on 3-year Treasury securities? Round your answer to two decimal places.
%
8

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Solution

r* = 4%; I1 = 2%; I2 = 5%; I3 = 5%; MRP = 0; rT-2 = ?; rT-3 = ?

r = r* + IP + DRP + LP + MRP.
Since these are Treasury securities, DRP = LP = 0.
rT-2 = r* + IP2

IP2 = (2% + 5%)/2 = 3.50%

rT-2 = 4.00% + 3.50% = 7.50%.

rT-3 = r* + IP3

IP3 = (2% + 5% + 5%)/3 = 4.00%

rT-3 = 4.00% + 4.00% = 8.00%.

Solution
Correct Response

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Problem 5-4
Determinant of Interest Rates
The real risk-free rate of interest is 4%. Inflation is expected to be 2% this year and 5% during the next
2 years. Assume that the maturity risk premium is zero.
What is the yield on 2-year Treasury securities? Round your answer to two decimal places.
%
7.50
What is the yield on 3-year Treasury securities? Round your answer to two decimal places.
%
8.00

Problem 5-4
Determinant of Interest Rates
The real risk-free rate of interest is 3%. Inflation is expected to be 1% this year and 4% during the next
2 years. Assume that the maturity risk premium is zero.
What is the yield on 2-year Treasury securities? Round your answer to two decimal places.
%
2.5
What is the yield on 3-year Treasury securities? Round your answer to two decimal places.
%
3

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Solution

r* = 3%; I1 = 1%; I2 = 4%; I3 = 4%; MRP = 0; rT-2 = ?; rT-3 = ?

r = r* + IP + DRP + LP + MRP.
Since these are Treasury securities, DRP = LP = 0.
rT-2 = r* + IP2
IP2 = (1% + 4%)/2 = 2.50%

rT-2 = 3.00% + 2.50% = 5.50%.

rT-3 = r* + IP3

IP3 = (1% + 4% + 4%)/3 = 3.00%

rT-3 = 3.00% + 3.00% = 6.00%.

Solution
Correct Response

Click here to read the eBook: The Pre-Tax Cost of Debt: Determinants of Market Interest Rates

Problem 5-4
Determinant of Interest Rates
The real risk-free rate of interest is 3%. Inflation is expected to be 1% this year and 4% during the next
2 years. Assume that the maturity risk premium is zero.
What is the yield on 2-year Treasury securities? Round your answer to two decimal places.
%
5.50
What is the yield on 3-year Treasury securities? Round your answer to two decimal places.
%
6.00

Problem 5-5
Default Risk Premium
A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has a yield of
9%. Assume that the liquidity premium on the corporate bond is 0.3%. What is the default risk
premium on the corporate bond? Round your answer to two decimal places.
%
.3

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Solution

rT-10 = 6%; rC-10 = 9%; LP = 0.3%; DRP = ?

r = r* + IP + DRP + LP + MRP.
rT-10 = 6% = r* + IP + MRP; DRP = LP = 0.
rC-10 = 9% = r* + IP + DRP + 0.3% + MRP.
Because both bonds are 10-year bonds the inflation premium and maturity
risk premium on both bonds are equal. The only difference between them is
the liquidity and default risk premiums.
rC-10 = 9% = r* + IP + MRP + 0.3% + DRP. But we know from above that r*
+ IP + MRP = 6%; therefore,
rC-10 = 9% = 6% + 0.3% + DRP

2.7% = DRP.
Solution
Correct Response

Click here to read the eBook: The Pre-Tax Cost of Debt: Determinants of Market Interest Rates

Problem 5-5
Default Risk Premium
A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has a yield of
9%. Assume that the liquidity premium on the corporate bond is 0.3%. What is the default risk
premium on the corporate bond? Round your answer to two decimal places.
%
2.70

Problem 5-6
Maturity Risk Premium
The real risk-free rate is 3%, and inflation is expected to be 2% for the next 2 years. A 2-year Treasury
security yields 8.2%. What is the maturity risk premium for the 2-year security?
%
1.2

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Solution

r* = 3%; IP = 2%; rT-2 = 8.2%; MRP2 = ?

rT-2 = r* + IP + MRP = 8.2%

rT-2 = 3% + 2% + MRP = 8.2%

MRP = 3.20%.
Solution
Correct Response

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Problem 5-6
Maturity Risk Premium
The real risk-free rate is 3%, and inflation is expected to be 2% for the next 2 years. A 2-year Treasury
security yields 8.2%. What is the maturity risk premium for the 2-year security?
%
3.20

Problem 5-6
Maturity Risk Premium
The real risk-free rate is 3%, and inflation is expected to be 4% for the next 2 years. A 2-year Treasury
security yields 8.1%. What is the maturity risk premium for the 2-year security?
%
1.1

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Solution

r* = 3%; IP = 4%; rT-2 = 8.1%; MRP2 = ?

rT-2 = r* + IP + MRP = 8.1%

rT-2 = 3% + 4% + MRP = 8.1%

MRP = 1.10%.
Solution
Correct Response

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Problem 5-6
Maturity Risk Premium
The real risk-free rate is 3%, and inflation is expected to be 4% for the next 2 years. A 2-year Treasury
security yields 8.1%. What is the maturity risk premium for the 2-year security?
%
1.10
Problem 5-7
Bond Valuation with Semiannual Payments
Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually. The bonds
mature in 8 years, have a face value of $1,000, and a yield to maturity of 10.5%. What is the price of
the bonds? Round your answer to the nearest cent.
$
866.91

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Solution

The problem asks you to find the price of a bond, given the following facts:
N = 16; I/YR = 10.5%/2 = 5.25%; PMT = 50; FV = 1,000.
With a financial calculator, solve for PV = $973.38
Solution
Correct Response

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Problem 5-7
Bond Valuation with Semiannual Payments
Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually. The bonds
mature in 8 years, have a face value of $1,000, and a yield to maturity of 10.5%. What is the price of
the bonds? Round your answer to the nearest cent.
$
973.38

Problem 5-7
Bond Valuation with Semiannual Payments
Renfro Rentals has issued bonds that have a 9% coupon rate, payable semiannually. The bonds
mature in 18 years, have a face value of $1,000, and a yield to maturity of 7%. What is the price of
the bonds? Round your answer to the nearest cent.
$
1201.18

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Solution

The problem asks you to find the price of a bond, given the following facts:
N = 36; I/YR = 7%/2 = 3.5%; PMT = 45; FV = 1,000.
With a financial calculator, solve for PV = $1,202.90
Solution
Correct Response

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Problem 5-7
Bond Valuation with Semiannual Payments
Renfro Rentals has issued bonds that have a 9% coupon rate, payable semiannually. The bonds mature
in 18 years, have a face value of $1,000, and a yield to maturity of 7%. What is the price of the bonds?
Round your answer to the nearest cent.
$
1202.90

Problem 5-8
Yield to Maturity and Call with Semiannual Payments
Thatcher Corporation's bonds will mature in 15 years. The bonds have a face value of $1,000 and an
7.5% coupon rate, paid semiannually. The price of the bonds is $900. The bonds are callable in 5 years
at a call price of $1,050. Round your answers to two decimal places.
What is their yield to maturity?
%
8.72
What is their yield to call?
%
11.01

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Solution

With your financial calculator, enter the following to find YTM:

N = 15 x 2 = 30; PV = -900; PMT = 0.075/2 x 1,000 = 37.5; FV = 1,000;
I/YR = YTM = ?

YTM = 4.355% x 2 = 8.71%.

With your financial calculator, enter the following to find YTC:
N = 5 x 2 = 10; PV = -900; PMT = 0.075/2 x 1,000 = 37.5; FV = 1,050; I/YR
= YTC = ?

YTC = 5.465% x 2 = 10.93%.

Solution
Correct Response

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Yields

Problem 5-8
Yield to Maturity and Call with Semiannual Payments
Thatcher Corporation's bonds will mature in 15 years. The bonds have a face value of $1,000 and an
7.5% coupon rate, paid semiannually. The price of the bonds is $900. The bonds are callable in 5 years
at a call price of $1,050. Round your answers to two decimal places.
What is their yield to maturity?
%
8.71
What is their yield to call?
%
10.93

Problem 5-11
Yield to Call and Realized Rates of Return
Seven years ago, Goodwynn & Wolf Incorporated sold a 20-year bond issue with a 14% annual coupon
rate and a 9% call premium. Today, G&W called the bonds. The bonds originally were sold at their face
value of $1,000. Compute the realized rate of return for investors who purchased the bonds when they
were issued and who surrender them today in exchange for the call price. Round your answer to two
decimal places.
%
14.82

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Solution

N = 7; PV = -1,000; PMT = 140; FV = 1,090; I/YR = ? Solve for I/YR =

14.82%.
Solution
Correct Response

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Problem 5-11
Yield to Call and Realized Rates of Return
Seven years ago, Goodwynn & Wolf Incorporated sold a 20-year bond issue with a 14% annual coupon
rate and a 9% call premium. Today, G&W called the bonds. The bonds originally were sold at their face
value of $1,000. Compute the realized rate of return for investors who purchased the bonds when they
were issued and who surrender them today in exchange for the call price. Round your answer to two
decimal places.
%
14.82

Problem 5-13
Yield to Maturity and Current Yield
You just purchased a bond that matures in 12 years. The bond has a face value of $1,000 and has an
7% annual coupon. The bond has a current yield of 5.74%. What is the bond's yield to maturity? Round
your answer to two decimal places.
%
4.58

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Solution

The problem asks you to solve for the YTM, given the following facts:
N = 12, PMT = 70, and FV = 1,000. In order to solve for I/YR we need PV.
However, you are also given that the current yield is equal to 5.74%. Given
this information, we can find PV.
Current = Annual interest/Current
yield price

0.0574 = $70/PV

PV = $70/0.0574 = $1,219.51.

Now, solve for the YTM with a financial calculator:

N = 12, PV = 1,219.51, PMT = 70, and FV = 1,000. Solve for I/YR = YTM =
4.58%.
Solution
Correct Response
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Problem 5-13
Yield to Maturity and Current Yield
You just purchased a bond that matures in 12 years. The bond has a face value of $1,000 and has an
7% annual coupon. The bond has a current yield of 5.74%. What is the bond's yield to maturity? Round
your answer to two decimal places.
%
4.58